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Updated July 30, 2026. Quick answer (2026): Taxable-first is a sound default, not a rule. With a 95% embedded gain and a 20% capital gain rate, selling costs 19% per dollar – more than a 12% ordinary bracket. The default inverts.
Knowing your real embedded gain is the input that decides this.
Most people do not know their cost basis by lot, and it is what determines whether the default holds for them.
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A good default, promoted into a law it never was
Spend taxable first, then tax-deferred, then Roth. It is sound in the ordinary case, and it is repeated as though it holds universally. It does not.
The arithmetic that breaks it
A taxable withdrawal is taxed only on the gain portion. So its cost per dollar is embedded gain fraction × capital gain rate, not the capital gain rate itself. With a 40% embedded gain and a 15% rate that is 6 cents per dollar — cheap against almost any ordinary bracket.
Now take a long-held position with a 95% embedded gain and a 20% capital gain rate: 19 cents per dollar. Against a 12% ordinary bracket, the tax-deferred account is now the cheaper source, and taxable-first costs you money.
Which conditions flip it
- Highly appreciated positions, especially decades-held index funds or inherited-then-grown stock.
- A low ordinary bracket — most common in exactly the pre-Social-Security window.
- Capital gain rates at 20% plus the 3.8% net investment income tax, where the effective rate on the gain slice climbs further.
The one case where taxable-first is close to unarguable
When the embedded gain is small or negative. Selling a position at or near basis costs almost nothing in tax and leaves every tax-advantaged dollar compounding. That is the situation the rule of thumb was built from — and stating the condition is more useful than repeating the rule.
Related
Methodology
- This is a single-year, deterministic comparison of the marginal tax cost of one more dollar from each account type. It does not project returns, future brackets, or a lifetime drawdown path, because those depend on assumptions no calculator can verify.
- Every rate is a USER INPUT. Ordinary brackets, long-term capital gain brackets and IRMAA tiers are all indexed annually, so none of them is hardcoded anywhere in this cluster.
- A required minimum distribution is taken first because it is mandatory, not because it is cheapest. Roth is placed last regardless of the single-year arithmetic, which would otherwise drain it first.
- Figures were computed by two independently written engines that agree to the cent, with invariants asserting RMD-first ordering, Roth-last ordering, and that a shortfall is reported rather than silently satisfied.
- Federal only, and excludes state tax, the taxation of Social Security benefits, and ACA premium credits.
Educational estimate, not tax advice. Confirm anything that changes a filing or distribution decision with a CPA.
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